Tax Plus Tariff May Be a Winning Solution (Subscribers Only)

If a carbon tax works, it will be because it places a price on goods and services that are particularly emissions intensive, driving demand away from them and towards lower emissions alternatives. If the entire Australian economy was served only by Australian businesses that operated in Australia, the tax would work to adjust behaviour in a reasonably straight forward manner.

However, the Australian economy is very open and domestic businesses are under sustained pressure from international competitors. A carbon tax applied domestically will increase domestic prices, but not the price of imports or services from overseas. Any loss of domestic economic activity because of a carbon price applied in this way is carbon leakage. Not surprisingly, many Australian businesses are up in arms about this prospect.

Those sectors that already face substantial competition and are under pressure include some of the most emissions intensive. Industries like pulp and paper manufacture, cement, aluminium and steel are all operating marginally and could reach a tipping point easily.

That is why under the negotiations for the Carbon Pollution Reduction Scheme in 2008 and 2009, they were slated to receive significant compensation to protect them. Nothing has changed under the carbon tax, except the compensatory measures don’t seem to be on offer.

Rightly, this situation has a range of domestic companies – especially manufacturers – very concerned.

Take for instance BlueScope Steel’s Paul O’Malley. He has been clear that his business is likely to close several steel mills if the situation is not sorted out. The company says that at AUD25 per tonne of carbon dioxide, the costs to them would be around AUD300 million per annum.

O’Malley’s proposal is for only energy generators to pay a carbon tax and for manufacturers to be compensated. While that’s not likely, there are some other options that have some chance of success.

The major proposition with currency in industry is for some form of tariff (the modern euphemism is a ‘border adjustment mechanism’), so that imported goods and services carry the same costs as those produced domestically. The Grattan Institute proposed something similar in 2010, but suggested it be limited to just a couple of trade exposed and high emitting industries.

Advocates of such measures quote both economic and environmental reasons for taking this approach. A churn of economic activity that sees manufacturing shift to another country is hard for most people to swallow, let alone justify for a unilateral carbon tax. The potential job losses alone are enough to make a ‘domestic only’ carbon tax unpalatable.

Importantly, without some form of condition equalising tariff regime, the signal to the international market would be against the domestic policy. That is, Australia’s competitors would be discouraged, not encouraged, to apply a price on carbon of their own if they are gaining from their competitor having applied a price. That’s what is called a perverse public policy outcome.

Environmentally, the minimum expectation is that a carbon tax not applied to exports would result in manufacturing and its associated emissions shifting to other countries. In many cases, countries that not only would have no price on carbon but whose goods would have to do ‘carbon miles’ to reach Australian markets and that may be manufactured with energy creating more emissions.

The only variant on this prognosis is that while a carbon tax that is applied only domestically leads to short term economic pain, it ultimately repositions the national economy to a low carbon future that all must eventually follow. That argument may be correct in theory, but try telling that to the manufacturer whose business declines or the workers that lose their jobs.

None of this is an argument for not pricing carbon. Neither is it an argument for one particular form of carbon pricing mechanism over another. It is however powerful food for thought in framing a far reaching domestic policy.

It is not inevitable we will have a carbon tax in Australia, followed by an emissions trading scheme. Should it come about, we should expect at least some form of border adjustment mechanism to be part of the system.

 

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